By Trent Derrick, CMT
Many local business owners come to me looking for an effective tax strategy that can offer tax savings year after year, while also creating an efficient avenue to invest for retirement. For many business owners, there are significant tax savings to be gained by creating an S-corp for your business and a SEP IRA to help you save efficiently for retirement.
With the help of my CPA network, your business can take on a more “official” structure with an S-corp and incur significant tax savings—both for your business and your retirement. Together, we can leverage our professional relationships to manage your business’s cash flow to your advantage.
Maybe you have started setting up an S-corp. What other strategies can you utilize to save on taxes and invest for retirement? Below are the three strategies I typically advise local business owners of pursuing when setting up an S-corp for their business.
Create And Contribute Toward A SEP
When we create a SEP IRA and put a plan together that allows you to contribute to it, this can provide you with substantial tax savings both now and down the line. Setting up a SEP IRA creates a tax deduction for you and your business and allows your retirement funds to potentially grow. Through this strategy, you are not simply throwing away your money, you are taking the profits you have earned and allowing the investment to possibly grow and compound. This works wonders for people who are self-employed and want to contribute moderately to their retirement plan.
SEP IRA Benefits
SEP IRAs are known for being low maintenance and having an easy setup, as opposed to other retirement plans. They also allow higher contributions than some other retirement plans, and furthermore, as a business owner, you are not required to contribute every year. This allows you some wiggle room if you have had a particularly difficult year. (1)
SEP IRA Rules
There are certain rules and requirements specific to SEPs that you must adhere to when your business is established as an S-corp. First, to open a SEP IRA, you must have some business income and you must have a W-2 paid to you from your business.
Additionally, SEPs are advantageous for business owners who are just setting up their tax-planning strategy too, because the final deadline to establish and contribute to your SEP IRA is your tax-filing deadline.
If your business has employees, you can also set up a SEP IRA for them if they are at least 21 years old, worked for your firm for three of the last five years, and have earned more than $650 in a year (2021).
You can contribute up to $58,000 or 25% of your annual compensation (2021), whichever is less. However, as the business owner, you must contribute the same percentage of contributions to your employees’ accounts as well as your own. (2)
Change Your Tax Rate
One of the benefits of setting up an S-corp is you can make every dollar work harder for you. Setting up an S-corp allows you to pay yourself from your business and it will change how your tax is calculated. This is because by paying yourself from your company, you will achieve a lower tax rate for both you and your company—and thus pay less in taxes overall.
The Cost of Inaction Is Steep
Delaying setting up a tax-advantageous strategy for your business will cost you. For example, we estimated a marginal tax rate for two businesses, one is an S-corp and the second a sole proprietorship, both with a total income of $150,000. The S-corp business allowed for an estimated marginal tax rate of 35%, while the sole proprietorship tax rate was 45%.This means that just by using the tax and retirement strategies offered through the S-corp, a small business owner could manage to save thousands and still manage to contribute to their retirement plan. Naturally, a ‘Real-World’ tax situation is likely to be more complicated, so please consult your tax advisor on how this may apply to you. Book a consultation with me here or email me at firstname.lastname@example.org.
About TrentTrent Derrick is a Financial Advisor and Chief Market Technician at Legacy Wealth Management. Trent is passionate about the value small businesses bring to their communities and specializes in serving small business owners by providing seamless financial advisory services tailored to their financial needs, including tax planning, cash flow management, retirement planning, and bookkeeping. Trent has a bachelor’s degree from the College of Charleston and studied economics at the University of South Carolina, Columbia. He is a Chartered Market Technician® (CMT). Trent serves as a guest lecturer for the College of Charleston’s MBA program and acts as chairman of the Market Technician Association’s Charleston chapter. When he’s not working, Trent, a proud Eagle Scout, enjoys volunteering with the Charleston Animal Shelter’s outreach program. Trent and his wife love to cook international cuisines and host dinner parties with their friends. To learn more about Trent, connect with him on LinkedIn.